Notes to Consolidated Financial Statements
National City Corporation ("National City" or "the Corporation") is a multi-bank holding company headquartered in Cleveland, Ohio.1. Summary of Significant Accounting Policies
The accounting and reporting policies of National City conform with generally accepted accounting principles and prevailing industry practices. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Principles of Consolidation and Basis of Presentation: The consolidated financial statements include the accounts of the Corporation and its subsidiaries. All material intercompany transactions and balances have been eliminated. The consolidated financial statements have been prepared to give retroactive effect to the March 31, 1998 merger with First of America Bank Corporation which was accounted for as a pooling of interests. Certain prior year amounts have been reclassified to conform with the current year presentation.
Business Combinations: Business combinations which have been accounted for under the purchase method of accounting include the results of operations of the acquired businesses from the date of acquisition. Net assets of the companies acquired were recorded at their estimated fair value as of the date of acquisition.
Other business combinations have been accounted for under the pooling-of-interests method of accounting which requires the assets, liabilities and shareholders' equity of the merged entity to be retroactively combined with the Corporation's respective accounts at recorded value. Prior period financial statements have been restated to give effect to business combinations accounted for under this method.
Cash Flows: Cash and cash equivalents are defined as those amounts included in the balance sheet caption "Cash and demand balances due from banks."
Loans: Loans are generally reported at the principal amount outstanding, net of unearned income. Loans held for sale are valued at the lower of cost or market, as calculated on an aggregate basis.
Loan origination fees and certain direct costs are amortized into interest or other income using a method which approximates the interest method over the estimated life of the related loan.
Loans are classified as nonaccrual or restructured based on management's judgment and requirements established by bank regulatory agencies. Subsequent receipts on nonaccrual loans, including those considered impaired under the provisions of Statement of Financial Accounting Standards No. 114, are recorded as a reduction of principal, and interest income is recorded once principal recovery is reasonably assured.
Allowance for Loan Losses: The allowance for loan losses is that amount believed adequate to absorb estimated credit losses in the portfolio based on management's evaluation of various factors including overall growth in the portfolio, an analysis of individual credits, adverse situations that could affect a borrower's ability to repay (including the timing of future payments), prior and current loss experience, and economic conditions. A provision for loan losses is charged to operations based on management's periodic evaluation of these and other pertinent factors.
Certain loans are accounted for under the provisions of Statement of Financial Accounting Standards ("SFAS") No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures. These standards require an allowance to be established as a component of the allowance for loan losses for certain loans when it is probable that all amounts due pursuant to the contractual terms of the loan will not be collected and the recorded investment in the loan exceeds the fair value. Fair value is measured using either the present value of expected future cash flows based on the initial effective interest rate on the loan, the observable market price of the loan or the fair value of the collateral if the loan is collateral dependent.
Securities and Trading Account Assets: Trading account assets are held for resale in anticipation of short-term market movements and are carried at market value. Gains and losses, both realized and unrealized, are included in other income.
Securities are classified as held to maturity when management has the positive intent and ability to hold the securities to maturity. Securities held to maturity, when present, are carried at amortized cost.
Securities not classified as held to maturity or trading are classified as available for sale. Securities available for sale are carried at fair value with unrealized gains and losses reported separately through accumulated other comprehensive income, net of tax.
Interest and dividends on securities, including amortization of premiums and accretion of discounts, are included in interest income. The adjusted cost of specific securities sold is used to compute gains or losses on sales.
Equity-Related Investments: Equity investments of the Corporation's venture capital and small business investment subsidiaries are included in other assets. These investments are carried at fair value with changes in fair value recognized in other noninterest income. The fair values of publicly traded investments are determined using quoted market prices adjusted for sales restrictions or market illiquidity. Investments that are not publicly traded are carried at cost together with any other-than-temporary valuation adjustments determined appropriate by management. This adjusted cost basis approximates fair value.
Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase: Securities purchased under agreements to resell and securities sold under agreements to repurchase are generally treated as collateralized financing transactions and are recorded at the amount at which the securities were acquired or sold plus accrued interest. It is the Corporation's policy to take possession of securities purchased under resale agreements, which are primarily U.S. Government and Federal agency securities. The market value of the collateral is monitored and additional collateral obtained when deemed appropriate. The Corporation also monitors its exposure with respect to securities borrowed transactions and requests the return of excess collateral as required.
Intangibles: The excess of the purchase price over net identifiable tangible and intangible assets acquired in a purchase business combination (goodwill) is included in other assets. Goodwill related to bank acquisitions is amortized over varying periods not exceeding 25 years. Goodwill related to nonbank acquisitions is amortized over varying periods not exceeding 40 years, based on industry practice within the respective nonbank industry. Other identified intangibles are amortized over periods ranging from 4 to 15 years.
Mortgage Servicing Rights: The total cost of loans originated or purchased is allocated between loans and servicing rights based on the relative fair values of each. The servicing rights capitalized are amortized in proportion to and over the period of estimated servicing income. Management stratifies servicing rights based on origination period and interest rate and evaluates the recoverability in relation to the impact of actual and anticipated loan portfolio prepayment, foreclosure and delinquency experience. Capitalized mortgage servicing rights are included in other assets and totaled $564.0 million and $262.6 million at December 31, 1998 and 1997, respectively. The Corporation hedges its exposure to the prepayment risk associated with the servicing rights by using off-balance sheet derivative financial instruments.
Depreciable Assets: Properties and equipment are stated at cost less accumulated depreciation and amortization. Buildings and equipment are depreciated on a straight-line basis over their useful lives. Leasehold improvements are amortized over the lives of the leases. Maintenance and repairs are charged to expense as incurred, while improvements which extend the useful life are capitalized and depreciated over the remaining life.
Long-lived assets to be held and those to be disposed of and certain intangibles are evaluated for impairment using the guidance provided by SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. The provisions of this statement establish when an impairment loss should be recognized and how it should be measured.
Derivative Financial Instruments:
Interest Rate Risk Management: As part of managing the Corporation's interest rate risk, a variety of derivative financial instruments are used to hedge market values and to alter the cash flow characteristics of certain on-balance sheet instruments. The derivative financial instruments used primarily consist of interest rate swaps and interest rate caps and floors, and, to a lesser extent, interest rate futures, forwards and options. The derivative instruments used to manage interest rate risk are linked with a specific asset or liability or a group of related assets or liabilities at the inception of the derivative contract and have a high degree of correlation with the associated balance sheet item during the hedge period. Net interest income or expense on derivative contracts used for interest rate risk management is accrued. Realized gains and losses on contracts, either settled or terminated, are deferred and are recorded as either an adjustment to the carrying value of the related on-balance sheet asset or liability or in other assets or other liabilities. Deferred amounts are amortized into interest income or expense over either the remaining original life of the derivative instrument or the expected life of the associated asset or liability. Unrealized gains or losses on these contracts are not recognized on the balance sheet, except for those contracts linked to available-for-sale securities, which are carried at fair value with changes in market value, net of interest accruals, recorded as other comprehensive income within stockholders' equity, net of tax.
Mortgage Servicing Rights Risk Management: The market value of the Corporation's mortgage servicing rights portfolio is adversely affected when mortgage interest rates decline and mortgage loan prepayments increase. To hedge the market value of the servicing rights portfolio the Corporation uses interest rate swaps, principal-only swaps and interest rate caps and floors. Net cash flows related to these contracts are recognized as adjustments to the carrying value of the mortgage servicing rights and are amortized over the life of the derivative instrument. This adjusted carrying value is the basis used for evaluating the recoverability of the servicing rights as described in the Mortgage Servicing Rights accounting policy. Unrealized gains and losses are not recognized on the balance sheet but are considered when evaluating the recoverability of the servicing rights.
Trading: The Corporation also enters into derivative financial agreements for trading purposes. These transactions are executed primarily with the Corporation's customers to facilitate their interest rate and foreign currency risk management strategies. Derivative instruments used for trading include interest rate swaps, interest rate caps and floors, and interest rate and foreign exchange futures, forwards and options. Changes in market value (both realized and unrealized) are recorded in other income.
Stock-Based Compensation: The Corporation's stock-based compensation plans are accounted for under the provisions of Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations. SFAS No. 123, Stock-Based Compensation, allows a company to recognize stock-based compensation using a fair-value based method of accounting if it so elects. The Corporation has elected not to adopt the recognition provisions of SFAS No. 123.
Income Taxes: Deferred income taxes reflect the temporary tax consequences on future years of differences between the tax bases and financial statement amounts of assets and liabilities at each year-end.
An effective tax rate of 35% is used to determine after-tax components of other comprehensive income included in the statements of changes in stockholders' equity.
Treasury Stock: Acquisitions of treasury stock are recorded on the par value method, which requires the cash paid to be allocated to common or preferred stock, surplus and retained earnings.
2. Recent Accounting Pronouncements
Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities: Certain provisions of SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, relating to repurchase agreements, securities lending and other similar transactions, and pledged collateral, were deferred for one year by SFAS No. 127, and were adopted prospectively as of January 1, 1998. SFAS No. 125 established new criteria for determining whether a transfer of financial assets in exchange for cash or other consideration should be accounted for as a sale or as a pledge of collateral in a secured borrowing and also established new accounting requirements for pledged collateral. The adoption of these provisions did not have a material impact on financial position or results or operations.
Reporting Comprehensive Income: In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, Reporting Comprehensive Income. This statement establishes standards for reporting the components of comprehensive income and requires that all items that are required to be recognized under accounting standards as components of comprehensive income be included in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income includes net income as well as certain items that are reported directly within a separate component of stockholders' equity and bypass net income. The Corporation adopted the provisions of this statement in 1998. These disclosure requirements had no impact on financial position or results of operations.
Disclosures About Segments of an Enterprise and Related Information: In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. The provisions of this statement require disclosure of financial and descriptive information about an enterprise's operating segments in annual and interim financial reports issued to shareholders. The statement defines an operating segment as a component of an enterprise that engages in business activities that generate revenue and incur expense, whose operating results are reviewed by the chief operating decision maker in the determination of resource allocation and performance, and for which discrete financial information is available. The Corporation adopted the provisions of this statement for 1998 annual reporting. These disclosure requirements had no impact on financial position or results of operations.
Accounting for Derivative Instruments and Hedging Activities: In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The provisions of this statement require that derivative instruments be carried at fair value on the balance sheet. The statement continues to allow derivative instruments to be used to hedge various risks and sets forth specific criteria to be used to determine when hedge accounting can be used. The statement also provides for offsetting changes in fair value or cash flows of both the derivative and the hedged asset or liability to be recognized in earnings in the same period; however, any changes in fair value or cash flow that represent the ineffective portion of a hedge are required to be recognized in earnings and cannot be deferred. For derivative instruments not accounted for as hedges, changes in fair value are required to be recognized in earnings.
The provisions of this statement become effective for quarterly and annual reporting beginning January 1, 2000. Although the statement allows for early adoption in any quarterly period after June 1998, National City has no plans to adopt the provisions of SFAS No. 133 prior to the effective date. The impact of adopting the provisions of this statement on National City's financial position, results of operations and cash flow subsequent to the effective date is not currently estimable and will depend on the financial position of the Corporation and the nature and purpose of the derivative instruments in use by management at that time.
3. Mergers and Acquisitions
On March 30, 1998, National City acquired Fort Wayne National Corporation (FWNC), a $3 billion asset bank holding company headquartered in Fort Wayne, Indiana, in a transaction accounted for as a purchase. Upon acquisition, each share of FWNC common stock outstanding was converted into .75 shares of National City common stock. A net of 10.8 million shares of National City common stock were issued. National City also issued .7 million shares of 6% Cumulative Convertible Preferred Stock, Series 1 in exchange for all of the outstanding shares of FWNC's 6% Cumulative Convertible Class B Preferred Stock. Goodwill of $536.0 million and core deposit intangible of $71.9 million were recorded in connection with the acquisition and are being amortized on a straight-line basis over twenty-five and seven years, respectively. The pro forma effects of this transaction are not material to historical results of operations.
On March 31, 1998, National City Corporation merged with First of America Bank Corporation (FOA), a $21 billion asset bank holding company headquartered in Kalamazoo, Michigan, in a transaction accounted for as a pooling of interests. National City issued 104.9 million shares of common stock to the shareholders of FOA based upon an exchange ratio of 1.2 shares of National City common stock for each outstanding share of FOA common stock. The historical consolidated financial statements have been restated to reflect this transaction.
Net interest income, net income and diluted net income per common share for National City and FOA as originally reported for the two years ended December 31, 1997 prior to restatement are as follows:
-------------------------------------------------------------- (Dollars in Thousands) 1997 1996 -------------------------------------------------------------- Net interest income National City $1,942,828 $1,942,576 First of America 871,922 902,488 -------------------------------------------------------------- Combined $2,814,750 $2,845,064 -------------------------------------------------------------- Net income National City $ 807,433 $ 736,630 First of America 314,761 256,886 -------------------------------------------------------------- Combined $1,122,194 $ 993,516 -------------------------------------------------------------- Diluted net income per common share National City $3.66 $3.27 First of America 3.53 2.77 Combined 3.42 2.95 --------------------------------------------------------------
Merger expenses incurred in 1998 as a result of the FOA and FWNC transactions totaled $379.4 million and consisted of: personnel-related costs in the amount of $109.8 million; facilities and equipment adjustments of $71.2 million; professional fees of $58.5 million; system conversion related costs of $48.3 million, and miscellaneous expenses of $91.6 million.
During 1997, the Corporation's item-processing subsidiary, National Processing, Inc., acquired several processing services companies. The combined purchase price of these acquisitions totaled $128 million. Goodwill generated as a result of these purchases totaled $104 million. The pro forma effects of the 1997 acquisitions were deemed not material to historical results of operations.
On May 3, 1996, National City merged with Integra Financial Corporation, a $14 billion asset bank holding company headquartered in Pittsburgh, Pennsylvania, in a transaction accounted for as a pooling of interests. National City issued 66.6 million shares of common stock to effect the merger.
4. Loans and Allowance for Loan Losses
Total loans outstanding were recorded net of unearned income of $599.7 million in 1998 and $438.8 million in 1997.
The following table summarizes the activity in the allowance for loan losses:
For the Calendar Year
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(Dollars in Thousands) 1998 1997 1996
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Balance at beginning of year $ 941,874 $ 958,739 $ 947,028
Allowance related to loans
acquired (sold) 27,501 (19,522) 94
Provision 201,400 225,367 239,936
Charge-offs (321,385) (360,792) (380,656)
Recoveries 120,853 138,082 152,337
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Net charge-offs (200,532) (222,710) (228,319)
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Balance at end of year $ 970,243 $ 941,874 $ 958,739
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The financial review section provides detail regarding nonperforming loans. At December 31, 1998 and December 31, 1997 loans that were considered to be impaired under SFAS No. 114 totaled $16.9 million and $28.8 million, respectively. All impaired loans are included in nonperforming assets. Management does not individually evaluate certain smaller-balance loans for impairment. These loans are evaluated on an aggregate basis using a formula-based approach in accordance with the Corporation's policy. The majority of the loans deemed impaired were evaluated using the fair value of the collateral as the measurement method. The related allowance allocated to impaired loans for 1998 and 1997 was $7.4 million and $10.1 million, respectively. All impaired loans at December 31, 1998 and 1997 had an associated allowance. The contractual interest due and actual interest recognized on impaired loans, as well as on total nonperforming assets, for the twelve months ended December 31, 1998, was $44.7 million and $10.2 million, compared to $31.5 million and $13.1 million, respectively, for the twelve months ended December 31, 1997.
At December 31, 1998, nonaccrual and restructured loans were $218.6 million and other real estate owned was $29.9 million. At December 31, 1997, the corresponding amounts were $237.8 million and $35.5 million, respectively.
5. Securities
The following is a summary of securities available for sale:
December 31, 1998
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(Dollars in Amortized Unrealized Unrealized Market
Thousands) Cost Gains Losses Value
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U.S. Treas. and Fed.
agency debentures $ 1,212,437 $ 33,914 $ 100 $ 1,246,251
Mortgage-backed
securities 9,717,908 107,350 15,926 9,809,332
Asset-backed and
corporate debt
securities 3,044,075 11,549 10,167 3,045,457
States and political
subdivisions 917,424 51,101 406 968,119
Other 809,154 241,148 91 1,050,211
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Total securities $15,700,998 $445,062 $26,690 $16,119,370
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December 31, 1997
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(Dollars in Amortized Unrealized Unrealized Market
Thousands) Cost Gains Losses Value
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U.S. Treas. and Fed.
agency debentures $ 5,074,131 $ 27,903 $12,677 $ 5,089,357
Mortgage-backed
securities 5,223,467 71,616 17,073 5,278,010
Asset-backed and
corporate debt
securities 1,568,334 8,655 1,895 1,575,094
States and political
subdivisions 814,225 42,207 400 856,032
Other 585,445 413,743 115 999,073
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Total securities $13,265,602 $564,124 $32,160 $13,797,566
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Other securities include the Corporation's internally-managed equity portfolio of bank and thrift common stock investments, which had an amortized cost and market value of $395.0 million and $646.8 million, respectively, at December 31, 1998, and $204.8 million and $612.2 million, respectively, at December 31, 1997.
The Corporation's securities portfolio consists mainly of financial instruments that pay back par value upon maturity. Market value fluctuations occur over the lives of the instruments due to changes in market interest rates. Management has concluded that current declines in value are temporary and accordingly, no valuation adjustments have been included as a charge to income.
The following table shows the amortized cost and market value (carrying value) of securities at December 31, 1998 by maturity:
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Available for Sale
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(Dollars in Thousands) Amortized Cost Market Value
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Due in 1 year or less $ 2,129,928 $ 2,138,517
Due in 1 to 5 years 7,704,912 7,789,132
Due in 5 to 10 years 4,398,779 4,458,659
Due after 10 years 1,467,379 1,733,062
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Total $15,700,998 $16,119,370
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Mortgage-backed securities and other securities which have prepayment provisions are assigned to maturity categories based on estimated average lives. Equity securities are included in the Due after 10 years category.
At December 31, 1998, the carrying value of securities pledged to secure public and trust deposits, trading account liabilities, U.S. Treasury demand notes and security repurchase agreements totaled $12.9 billion.
At December 31, 1998, there were no securities of a single issuer, other than U.S. Treasury and other U.S. government agency securities, which exceeded 10% of stockholders' equity.
In 1998, 1997 and 1996, gross gains of $177.9 million, $96.5 million and $127.3 million and gross losses of $43.4 million, $15.3 million and $18.6 million were realized, respectively.
6. Fair Value of Financial Instruments
Fair value disclosures of financial instruments are made to comply with the requirements of SFAS No. 107, Disclosures About Fair Value of Financial Instruments. The market value of securities is primarily based upon quoted market prices. For substantially all other financial instruments, the fair values are management's estimates of the values at which the instruments could be exchanged in a transaction between willing parties. Fair values are based on estimates using present value and other valuation techniques in instances where quoted market prices are not available. These techniques are significantly affected by the assumptions used, including discount rates and estimates of future cash flows. As such, the derived fair value estimates cannot be substantiated by comparison to independent markets and, further, may not be realizable in an immediate settlement of the instruments.
SFAS No. 107 also excludes certain items from its disclosure requirements. These items include non-financial assets, intangibles and future business growth, as well as certain liabilities such as pension and other post-retirement benefits, deferred compensation arrangements and leases. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Corporation.
Portions of the unrealized gains and losses inherent in the valuation are a result of management's program to manage overall interest rate risk and represent a point in time valuation. It is not management's intention to immediately dispose of a significant portion of its financial instruments and, thus, the unrealized gains or losses should not be interpreted as a forecast of future earnings and cash flows.
The following table presents the estimates of fair value of financial instruments at December 31, 1998 and 1997. Bracketed amounts in the carrying value columns represent either reduction of asset accounts, liabilities, or commitments representing potential cash outflows. Bracketed amounts in the fair value columns represent estimated cash outflows required to settle the obligations at current market rates.
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1998 1997
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Carrying Fair Carrying Fair
(Dollars in Millions) Value Value Value Value
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Assets:
Cash and cash
equivalents $ 6,545 $ 6,545 $ 5,646 $ 5,646
Loans held for sale 3,507 3,507 1,250 1,250
Loans receivable 58,011 59,681 51,994 52,821
Allowance for loan
losses (970) (970) (942) (942)
Securities 16,119 16,119 13,978 13,978
Other assets 164 164 130 130
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Liabilities:
Demand deposits $(10,912) $(10,912) $(10,287) $(10,287)
Savings and time
deposits (47,335) (47,855) (42,330) (42,641)
Short-term borrowings (11,545) (11,545) (9,075) (9,075)
Long-term debt (9,689) (9,806) (6,297) (6,696)
Other liabilities (477) (477) (564) (564)
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Off-Balance Sheet Instruments:
Interest rate swaps $ 29 $ 156 $ (7) $ 70
Interest rate caps,
floors and futures (15) 36 18 4
Trading account
derivatives 19 19 5 5
Commitments to
extend credit (19) (19) (12) (12)
Standby letters of
credit (4) (4) (2) (2)
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The following methods and assumptions were used to estimate the fair value of each class of financial instrument:
Cash and Cash Equivalents: The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values. For purposes of this disclosure only, cash equivalents include Federal funds sold, security resale agreements, Eurodollar time deposits, customers' acceptance liability, accrued interest receivable and other short-term investments.
Loans Receivable and Loans Held for Sale: For performing variable rate loans that reprice frequently and loans held for sale, estimated fair values are based on carrying values. The fair values for all other loans are estimated using a discounted cash flow calculation that applies interest rates used to price new, similar loans to a schedule of aggregated expected monthly maturities, adjusted for market and credit risks.
Securities: The market values of securities are based upon quoted market prices, where available, and on quoted market prices of comparable instruments when specific quoted prices are not available.
Deposit Liabilities: The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amounts payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts for variable-rate money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Short-Term Borrowings: The carrying amounts of Federal funds purchased, borrowings under repurchase agreements, commercial paper, and other short-term borrowings approximate their fair values.
Long-Term Debt: The fair values of long-term borrowings (other than deposits) are based on quoted market prices, where available, or are estimated using discounted cash flow analyses based on the Corporation's current incremental borrowing rates for similar types of borrowing arrangements.
Off-Balance Sheet Instruments: The amounts shown under carrying value represent accruals or deferred income (fees) arising from the related off- balance sheet financial instruments. Fair values for off-balance sheet instruments (futures, swaps, forwards, options, guarantees and lending commitments) are based on quoted market prices (futures); current settlement values (financial forwards); quoted market prices of comparable instruments; fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing (guarantees, loan commitments); or, if there are no relevant comparables, on pricing models or formulas using current assumptions (interest rate swaps and options).
7. Cash and Demand Balances Due From Banks
The Corporation's subsidiary banks are required to maintain noninterest bearing reserve balances with the Federal Reserve Bank. The consolidated average reserve balance was $134.3 million for 1998.8. Properties and Equipment
A summary of properties and equipment follows:
December 31
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(Dollars in Thousands) 1998 1997
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Land $ 160,049 $ 154,917
Buildings and leasehold improvements 1,085,225 965,412
Equipment 1,239,007 1,032,895
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2,484,281 2,153,224
Less accumulated depreciation
and amortization 1,334,071 1,121,312
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Net properties and equipment $1,150,210 $1,031,912
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The Corporation and certain of its subsidiary banks occupy their respective headquarters offices and other facilities under long-term operating leases and, in addition, lease certain data processing equipment. The aggregate minimum annual rental commitments under these leases total approximately $76.6 million in 1999, $69.7 million in 2000, $62.1 million in 2001, $56.6 million in 2002, $51.8 million in 2003 and $213.2 million thereafter.
Total expense recorded under all operating leases in 1998, 1997 and 1996 was $104.2 million, $97.8 million and $96.2 million, respectively.
9. Other Borrowings
The composition of other borrowings follows:
December 31
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(Dollars in Thousands) 1998 1997
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U.S. Treasury demand notes and
Federal funds borrowed-term $ 916,342 $2,001,665
Notes payable to Student Loan
Marketing Association -- 300,000
FHLB advances 250,000 450,000
Bank Notes and other 556,313 716,702
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Total bank subsidiaries 1,722,655 3,468,367
Commercial paper 392,938 795,895
Other 2,323 294
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Total parent company and other
subsidiaries 395,261 796,189
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Total $2,117,916 $4,264,556
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U.S. Treasury demand notes represent secured borrowings from the U.S. Treasury. These borrowings are collateralized with securities or 1-4 family residential mortgage loans. The funds are placed with the banks at the discretion of the U.S. Treasury and may be called at any time.
The $300 million floating rate note payable to Student Loan Marketing Association outstanding at December 31, 1997 was secured by and provided funding for student loan receivables.
10. Long-Term Debt
The composition of long-term debt, net of unamortized discount, if applicable, follows:
December 31
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(Dollars in Thousands) 1998 1997
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9 7/8 % Subordinated Notes due 1999 $ 64,965 $ 64,918
6.50% Subordinated Notes due 2000 99,931 99,881
8.50% Subordinated Notes due 2002 99,920 99,896
6 5/8 % Subordinated Notes due 2004 249,330 249,201
7.75% Subordinated Notes due 2004 200,000 200,000
8.50% Subordinated Notes due 2004 150,000 150,000
7.20% Subordinated Notes due 2005 249,814 249,785
Other 10,000 10,939
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Total parent company 1,123,960 1,124,620
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6.50% Subordinated Notes due 2003 199,675 199,600
7.25% Subordinated Notes due 2010 223,107 222,944
6.30% Subordinated Notes due 2011 200,000 200,000
7.25% Subordinated Notes due 2011 197,475 197,278
Other 1,475 3,133
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Total subsidiary subordinated notes 821,732 822,955
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Total long-term debt qualifying for
Tier II Capital 1,945,692 1,947,575
Senior Bank Notes 4,992,219 2,394,055
Federal Home Loan Bank Advances 2,063,207 1,303,721
Other 8,330 1,951
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Total other long-term debt 7,063,756 3,699,727
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Total $9,009,448 $5,647,302
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All of the subordinated notes of the parent and bank subsidiaries pay interest semi-annually and may not be redeemed prior to maturity.
Long-term advances from the Federal Home Loan Bank (FHLB) are at fixed and variable rates and mature at various dates through 2023. The weighted average interest rate of the advances as of December 31, 1998 and 1997 was 5.45% and 5.97%, respectively. Advances from the FHLB are collateralized by qualifying securities and loans.
The Senior Bank Notes are at fixed and variable rates and mature at various dates through 2078. The weighted average interest rate of the notes as of December 31, 1998 and 1997 was 5.60% and 6.14%, respectively.
The majority of the Corporation's fixed rate debt has been effectively converted to variable rate debt through the use of off-balance sheet derivatives.
A credit agreement dated March 14, 1997, with a group of unaffiliated banks, allows the Corporation to borrow up to $350 million until February 1, 2001, with a provision to extend the expiration date under certain circumstances. The Corporation pays an annual facility fee of 10 basis points on the amount of the line. There were no borrowings outstanding under this agreement at December 31, 1998.
Long-term debt maturities for the next five years are as follows: $1,483 million in 1999; $2,173 million in 2000; $152 million in 2001; $527 million in 2002; and $1,238 million in 2003.
11. Corporation-Obligated Mandatorily Redeemable Capital Securities of Subsidiary Trusts Holding Solely Debentures of the Corporation
December 31
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(Dollars in Thousands) 1998 1997
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Capital Securities of National City
Capital Trust I $499,895 $499,892
Capital Securities of First of America
Capital Trust I 150,000 150,000
Capital Securities of Fort Wayne
Capital Trust I 30,000 --
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Total $679,895 $649,892
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The corporation-obligated mandatorily redeemable capital securities (the capital securities) of subsidiary trusts holding solely junior subordinated debt securities of the Corporation (the debentures) were issued by three statutory business trusts -- First of America Capital Trust I, Fort Wayne Capital Trust I and National City Capital Trust I, of which 100% of the common equity in each of the trusts is owned by the Corporation. The trusts were formed for the purpose of issuing the capital securities and investing the proceeds from the sale of such capital securities in the debentures. The debentures held by each trust are the sole assets of that trust. Distributions on the capital securities issued by each trust are payable semi-annually at a rate per annum equal to the interest rate being earned by the trust on the debentures held by that trust and are recorded as interest expense by the Corporation. The capital securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures. The Corporation has entered into agreements which, taken collectively, fully and unconditionally guarantee the capital securities subject to the terms of each of the guarantees.
The debentures held by First of America Capital Trust I have a stated maturity of January 31, 2027 and an interest rate of 8.12%. These debentures are first redeemable, in whole or in part, by the Corporation on January 31, 2007. The capital securities issued by First of America Capital Trust I qualify as Tier 1 capital under Federal Reserve Board guidelines.
The debentures held by the Fort Wayne Capital Trust I have a stated maturity of April 15, 2027 and an interest rate of 9.85%. These debentures are first redeemable, in whole or in part, by the Corporation on April 15, 2007. The Capital Securities issued by Fort Wayne Capital Trust I qualify as Tier 1 capital.
The debentures held by National City Capital Trust I have a stated maturity of June 1, 2029 and an interest rate of 6.75%. These debentures are first redeemable by the Corporation on June 1, 1999. If the debentures are not redeemed on June 1, 1999, the interest rate per annum will be reset based on an interest rate auction at that time. The capital securities issued by National City Capital Trust I currently do not qualify as Tier 1 capital.
12. Capital Ratios
The following table reflects various measures of capital at year-end:
1998 1997
(Dollars in ---------------- ----------------
Millions) Amount Ratio Amount Ratio
--------------------------------------------------------
Total equity(1) $7,012.9 7.95% $6,158.3 8.13%
Total common
equity(1) 6,976.8 7.91 6,158.3 8.13
Tangible common
equity(2) 5,850.6 6.72 5,595.3 7.44
Tier 1 capital(3) 5,538.5 7.74 5,435.1 8.93
Total risk-based
capital(4) 8,307.4 11.61 8,013.4 13.16
Leverage(5) 5,538.5 6.69 5,435.1 7.58
--------------------------------------------------------
(1) Computed in accordance with generally accepted accounting principles,
including unrealized market value adjustment of securities available for
sale.
(2) Stockholders' equity less all intangible assets; computed as a ratio to
total assets less intangible assets.
(3) Stockholders' equity less certain intangibles and the unrealized market
value adjustment of securities available for sale; computed as a ratio to
risk-adjusted assets, as defined.
(4) Tier 1 capital plus qualifying loan loss allowance and subordinated debt;
computed as a ratio to risk-adjusted assets, as defined.
(5) Tier 1 capital; computed as a ratio to average total assets less certain
intangibles.
------------------------------------------------------------
The parent company and its banking subsidiaries must meet specific capital requirements that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as set forth by banking industry regulators. Failure to meet minimum capital requirements can result in certain mandatory and possible additional discretionary actions by regulators that could have a material effect on a bank's operations. National City's Tier 1, total risk-based capital and leverage ratios are well above the required minimum capital levels of 4.00%, 8.00% and 4.00%, respectively. The capital levels at all of National City's subsidiary banks are maintained at or above the well-capitalized minimums of 6.00%, 10.00% and 5.00% for the Tier 1 capital, total risk-based capital and leverage ratios, respectively. As of December 31, 1998, National City and each of its affiliate banks were categorized as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since December 31, 1998 that management believes have changed any entity's capital category.
Intangible asset totals used in the capital ratio calculations are summarized below:
December 31
--------------------------------------------------------------
(Dollars in Millions) 1998 1997
--------------------------------------------------------------
Goodwill $1,043.3 $544.9
Other intangibles 82.9 18.1
-------- ------
Total intangibles $1,126.2 $563.0
--------------------------------------------------------------
13. Other Capital Transactions
As part of the acquisition of Fort Wayne National Corporation (FWNC), National City issued 739,976 shares of 6% Cumulative Convertible Preferred Stock, Series 1 in exchange for all of the outstanding shares of FWNC's 6% Cumulative Convertible Class B Preferred Stock. The preferred shares have a stated value of $50 per share. The holders of the preferred shares are entitled to receive cumulative preferred dividends payable quarterly at the annual rate of 6%. The preferred shares may be redeemed by National City at its option at any time, or from time to time, on or after April 1, 2002 at $50 per share, plus accrued and unpaid dividends. Such redemption may be subject to prior approval by the Federal Reserve Bank. Holders of the preferred shares have the right, at any time at their option, to convert each share of preferred stock into 1.51455 shares of National City common stock.
On October 26, 1998, the board of directors authorized the repurchase of up to 30 million shares of National City common stock in the open market or through privately negotiated transactions subject to an aggregate purchase limit of $2.7 billion. Five million shares were repurchased during the fourth quarter of 1998.
In August 1996, National Processing, Inc. (NPI), a subsidiary of National City, issued 7,475,000 shares of common stock in an underwritten public offering. Subsequent to the issuance, National City continued to own 85.2% of NPI. In 1997, National City increased its investment in NPI by approximately 2.5% through the purchase of 1.3 million shares of NPI's common stock on the open market. Amounts related to the minority shareholders' interest in the equity of NPI are not material to the consolidated financial statements.
14. Net Income Per Common Share
The calculation of net income per common share follows:
For the Calendar Year
-------------------------------------------------------------------
(Dollars in Thousands
Except Per Share Amounts) 1998 1997 1996
-------------------------------------------------------------------
Basic:
Net income $1,070,681 $1,122,194 $993,516
Less preferred
dividends 2,182 -- 4,028
-------------------------------------------------------------------
Net income applicable to
common stock $1,068,499 $1,122,194 $989,488
-------------------------------------------------------------------
Average common shares
outstanding 326,005,752 322,233,892 329,548,231
-------------------------------------------------------------------
Net income per common
share -- basic $3.28 $3.48 $3.00
-------------------------------------------------------------------
Diluted:
Net income $1,070,681 $1,122,194 $993,516
-------------------------------------------------------------------
Average common shares
outstanding 326,005,752 322,233,892 329,548,231
Stock option adjustment 6,020,125 5,498,692 4,321,731
Preferred stock
adjustment 834,288 -- 2,679,175
-------------------------------------------------------------------
Average common shares
outstanding -- diluted 332,860,165 327,732,584 336,549,137
-------------------------------------------------------------------
Net income per common
share -- diluted $3.22 $3.42 $2.95
-------------------------------------------------------------------
15. Parent Company and Regulatory Restrictions
At December 31, 1998, retained earnings of the parent company included $3,857.9 million of equity in undistributed earnings of subsidiaries.
Dividends paid by the Corporation's subsidiary banks are subject to various legal and regulatory restrictions. In 1998, subsidiary banks declared $752.2 million in dividends to the parent company. The subsidiary banks can initiate dividend payments in 1999, without prior regulatory approval, of $904.6 million, plus an additional amount equal to their net profits for 1999, as defined by statute, up to the date of any such dividend declaration.
Under Section 23A of the Federal Reserve Act, as amended, loans from subsidiary banks to nonbank affiliates, including the parent company, are required to be collateralized.
Commercial paper borrowings of a subsidiary ($392.9 million outstanding at December 31, 1998) are guaranteed by the parent company.
Condensed parent company financial statements, which include transactions with subsidiaries, follow:
Balance Sheets
December 31
---------------------------------------------------------------
(Dollars in Thousands) 1998 1997
---------------------------------------------------------------
Assets
Cash and demand balances
due from banks $ 192,499 $ 96,817
Loans to and accounts receivable
from subsidiaries 130,134 743,554
Securities 1,093,694 1,469,740
Investments in:
Subsidiary banks 7,058,754 5,111,422
Nonbank subsidiaries 511,087 535,117
Goodwill, net of accumulated
amortization 97,039 119,193
Other assets 241,827 300,458
---------------------------------------------------------------
Total assets $9,325,034 $8,376,301
---------------------------------------------------------------
Liabilities and stockholders' equity
Corporate long-term debt $1,659,056 $1,624,512
Accrued expenses and other
liabilities 653,070 593,529
---------------------------------------------------------------
Total liabilities 2,312,126 2,218,041
Stockholders' equity 7,012,908 6,158,260
---------------------------------------------------------------
Total liabilities and stockholders'
equity $9,325,034 $8,376,301
---------------------------------------------------------------
Statements of Income
For the Calendar Year
-----------------------------------------------------------------
(Dollars in Thousands) 1998 1997 1996
-----------------------------------------------------------------
Income
Dividends from:
Subsidiary banks $ 752,217 $ 664,348 $ 940,300
Nonbank subsidiaries 21,000 4,318 10,420
Interest on loans to
subsidiaries 28,034 23,153 10,810
Interest and dividends
on securities 33,590 38,268 27,511
Securities gains 109,906 65,929 93,720
Other income 13,588 212,169 139,847
-----------------------------------------------------------------
Total income 958,335 1,008,185 1,222,608
-----------------------------------------------------------------
Expense
Interest on debt and
other borrowings 129,586 118,556 97,918
Goodwill amortization 7,389 7,672 8,165
Other expense 310,108 328,213 312,127
-----------------------------------------------------------------
Total expense 447,083 454,441 418,210
-----------------------------------------------------------------
Income before taxes and
equity in undistributed
income of subsidiaries 511,252 553,744 804,398
Income tax (benefit) (60,621) (68,657) (99,507)
-----------------------------------------------------------------
Income before equity in
undistributed net
income
of subsidiaries 571,873 622,401 903,905
Equity in undistributed
net
income of subsidiaries 498,808 499,793 89,611
-----------------------------------------------------------------
Net income $1,070,681 $1,122,194 $ 993,516
-----------------------------------------------------------------
Statements of Cash Flows
For the Calendar Year
-----------------------------------------------------------------
(Dollars in Thousands) 1998 1997 1996
-----------------------------------------------------------------
Operating Activities
Net income $ 1,070,681 $1,122,194 $993,516
Adjustments to reconcile
net income to net cash
provided
by operating activities:
Equity in undistributed net
income of subsidiaries (498,808) (499,793) (89,611)
Amortization of goodwill 7,389 7,672 8,165
Depreciation of premises
and equipment 1,596 18,286 21,507
Decrease (increase) in
dividends receivable from
subsidiaries 35,000 223,820 (114,820)
Securities gains (109,906) (65,929) (93,720)
Other, net (104,770) 105,173 (146,870)
-----------------------------------------------------------------
Net cash provided
by operating activities 401,182 911,423 578,167
-----------------------------------------------------------------
Investing Activities
Net change in short-term
money market investments 446,003 (155,861) 29,065
Purchases of securities (577,267) (161,758) (260,765)
Sales and maturities of
securities 460,391 139,251 199,324
Net sales of premises and
equipment -- (12,057) 4,765
Principal collected on
loans to subsidiaries 260,721 594,820 8,524
Loans to subsidiaries (233,147) (741,689) (54,628)
Investment in subsidiaries (192,707) 9,948 --
Return of investment
from subsidiaries 310,000 495,000 198,000
Sale of subsidiary -- 160,000 --
-----------------------------------------------------------------
Net cash provided
by investing activities 473,994 327,654 124,285
-----------------------------------------------------------------
Financing Activities
Repayment of corporate
long-term debt (15,043) (129,023) (123,081)
Proceeds from issuance
of long-term debt -- 345,360 --
Decrease in other
borrowings (25,555) (1,163) (44,052)
Common and preferred
dividends (596,193) (477,931) (425,572)
Issuance of common stock 205,005 79,996 57,819
Repurchase of stock (347,708) (973,745) (175,110)
Shares distributed by ESOP -- -- 2,741
-----------------------------------------------------------------
Net cash (used)
by financing activities (779,494) (1,156,506) (707,255)
-----------------------------------------------------------------
Increase (decrease) in cash
and demand balances due
from banks 95,682 82,571 (4,803)
Cash and demand balances
due from banks, January 1 96,817 14,246 19,049
-----------------------------------------------------------------
Cash and demand balances
due from banks,
December 31 $ 192,499 $ 96,817 $ 14,246
-----------------------------------------------------------------
For the Calendar Year
-----------------------------------------------------------------
(Dollars in Thousands) 1998 1997 1996
-----------------------------------------------------------------
Supplemental Cash Flow Information
Interest paid $ 132,590 $ 117,917 $ 95,402
Securities transferred from
subsidiaries -- -- (248,234)
Shares issued in purchase
acquisitions 639,660 9,714 3,888
-----------------------------------------------------------------
16. Stock Options and Awards
National City maintains various incentive and non-qualified stock-based compensation plans that allow for the granting of restricted shares, stock options or other stock-based awards to eligible employees and directors.
Stock Option Plans: The stock option plans for officers and key employees authorize the issuance of up to 18,600,000 options to purchase shares of common stock at the market price of the shares at the date of grant. These options generally become exercisable to the extent of either 25% or 50% annually beginning one year from the date of grant and expire not later than ten years from the date of grant. In addition, stock options may be granted that include the right to receive additional options not exceeding the number of options exercised under the original grant if certain criteria are met. The exercise price of an additional option is equal to the market price of the common stock on the date the additional option is granted. Additional options vest six months from the date of grant and have a contractual term equal to the remaining term of the original option.
In 1995, the Corporation was authorized to grant up to 3,500,000 options to purchase common stock to virtually all employees in commemoration of National City's 150th anniversary. One-third of these options became exercisable in 1998. The remaining two thirds become exercisable in each of the years 1999 and 2000.
Restricted Stock Plan: The restricted stock plan provides for the issuance of up to 1,500,000 shares of common stock to officers, key employees and outside directors. In general, restrictions on outside directors' shares expire after nine months and restrictions on shares granted to key employees and officers expire within a four-year period. The Corporation generally recognizes compensation expense over the restricted period. Compensation expense recognized in 1998, 1997 and 1996 totaled $5.8 million, $3.2 million and $2.0 million, respectively, related to shares issued under this plan.
Option and Restricted Stock Award Activity: A summary of stock option and restricted stock award activity follows:
----------------------------------------------------------------------
Shares
-----------------------------------
Available Weighted-
for Grant Average
----------- Outstanding Option
Awards & --------------------- Price Per
Options Awards Options Share
--------------------------------------------------------------------
January 1, 1996 6,639,352 290,690 15,913,471 $24.54
Authorized 3,600,000 -- --
Cancelled 125,368 (11,300) (838,718) 29.21
Exercised -- (49,532) (3,350,988) 19.83
Granted (4,634,317) 237,377 5,015,803 33.69
--------------------------------------------------------------------
December 31, 1996 5,730,403 467,235 16,739,568 28.32
Authorized 16,500,000 -- --
Cancelled 151,415 (23,059) (173,999) 34.56
Exercised -- (77,803) (3,410,405) 21.71
Granted (3,877,279) 215,579 4,114,268 53.36
--------------------------------------------------------------------
December 31, 1997 18,504,539 581,952 17,269,432 33.66
Authorized -- -- --
Options acquired -- -- 498,559
FOA shares
cancelled (1,667,998) -- --
Cancelled 151,796 (16,048) (334,248) 41.29
Exercised -- (134,861) (4,321,888) 29.15
Granted (4,447,599) 249,705 4,762,723 68.20
--------------------------------------------------------------------
December 31, 1998 12,540,738 680,748 17,874,578 $43.82
--------------------------------------------------------------------
At December 31, 1998, 1997 and 1996, options exercisable under National City option plans totaled 9,343,619, 8,998,700, and 8,781,620 shares, respectively.
The following table summarizes information about stock options outstanding at December 31, 1998.
-------------------------------------------------------------------------------
Weighted
Average
Weighted Remaining Weighted
Average Contractual Average
Range of Exercise Life Exercise
Exercise Prices Outstanding Price (in years) Exercisable Price
-------------------------------------------------------------------------------
$6.94-23.99 2,314,846 $18.33 2.7 2,314,846 $18.34
24.00-34.99 6,862,029 30.55 6.5 4,548,110 29.95
35.00-44.99 653,334 36.76 4.9 653,334 36.76
45.00-54.99 651,030 47.93 7.0 582,152 47.67
55.00-64.99 2,870,740 57.74 8.2 1,118,261 57.68
65.00-74.69 4,522,599 68.46 9.3 126,916 70.43
-------------------------------------------------------------------------------
Total 17,874,578 $43.82 9,343,619 $30.83
-------------------------------------------------------------------------------
Pro Forma Disclosures: For purposes of providing the pro forma disclosures required under SFAS No. 123, the fair value of stock options granted in 1996, 1997 and 1998 was estimated at the date of grant using a Black-Scholes option pricing model. The Black-Scholes option pricing model was originally developed for use in estimating the fair value of traded options which have different characteristics from the Corporation's employee stock options. The model is also sensitive to changes in the subjective assumptions which can materially affect the fair value estimate. As a result, management believes that the Black-Scholes model may not necessarily provide a reliable single measure of the fair value of employee stock options.
The following weighted-average assumptions were used in the option pricing model: a risk-free interest rate of 4.54%, 5.70% and 6.04% for 1998, 1997 and 1996, respectively; an expected life of the option of 3.9 years for 1998 and 1997, and 4.2 years for 1996; an expected dividend yield of 3.00% for 1998, 3.50% for 1997 and 3.80% for 1996; and a volatility factor of .208 for 1998, .194 for 1997 and .206 for 1996. The weighted-average grant date fair value of options granted during 1998, 1997 and 1996 was $11.21, $9.12 and $6.41, respectively. For purposes of the pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period.
Had compensation cost for the Corporation's stock-based compensation plans been determined consistent with SFAS No. 123, net income and earnings per share would have been as summarized below:
(In Thousands, Except Per Share Amounts) 1998 1997 1996 ------------------------------------------------------------------ Pro forma net income $1,043,044 $1,103,911 $981,962 Pro forma earnings per share: Basic $3.19 $3.43 $2.97 Diluted 3.13 3.37 2.92 ------------------------------------------------------------------
Due to the inclusion of only 1996, 1997 and 1998 option grants, the effects of applying SFAS No. 123 to the years presented above may not be representative of the pro forma impact in future years.
17. Pension and Other Postretirement Benefit Plans
National City has a noncontributory, defined benefit retirement plan covering substantially all employees. Retirement benefits are based upon the employees' length of service and salary levels. Actuarially determined pension costs are charged to current operations. The funding policy is to pay at least the minimum amount required by the Employee Retirement Income Security Act of 1974.
National City also has a benefit plan which offers post-retirement medical and life insurance benefits. The medical portion of the plan is contributory and the life insurance coverage is noncontributory to the participants. The Corporation has no plan assets attributable to the plan and funds the benefits as claims arise. Post-retirement benefit costs are recognized in the periods during which employees provide service for such benefits. The Corporation reserves the right to terminate or make plan changes at any time.
The following table summarizes benefit obligation and plan asset activity for each of the plans.(1)
---------------------------------------------------------------------------
Other Post-
Retirement
Pension Benefits Benefits
----------------------- --------------------
(Dollars in Thousands) 1998 1997 1998 1997
---------------------------------------------------------------------------
Change in Fair Value of Plan Assets:
Balance at beginning of
measurement period $1,246,944 $1,074,997 $ -- $ --
Actual return on plan
assets 54,979 230,693 -- --
Employer contribution -- 79 6,879 6,233
Participant contribution -- -- 3,452 3,224
Settlements -- (2,513) -- --
Expenses paid (1,150) (1,323) -- --
Benefits paid (43,001) (54,989) (10,331) (9,457)
Acquisitions 36,745 -- -- --
---------------------------------------------------------------------------
Balance at end of
measurement period 1,294,517 1,246,944 -- --
---------------------------------------------------------------------------
Change in Benefit Obligation:
Balance at beginning of
measurement period 922,003 889,287 105,958 100,937
Service cost 31,180 39,328 2,072 2,521
Interest costs 63,924 66,594 7,363 7,752
Participant contribution -- -- 3,452 3,224
Actuarial (gains) losses 51,747 (23,279) 3,559 1,779
Settlements -- 3,245 -- --
Prior service cost -- 1,817 (4,017) (798)
Benefits paid (43,001) (54,989) (10,331) (9,457)
Acquisitions 27,936 -- -- --
Plan amendment (95,797) -- (904) --
---------------------------------------------------------------------------
Balance at end of
measurement period 957,992 922,003 107,152 105,958
---------------------------------------------------------------------------
Funded status 336,525 324,941 (107,152) (105,958)
Unamortized prior service
cost (73,766) 18,568 (2,722) 647
Unrecognized net actuarial
loss (162,456) (263,738) 8,525 5,994
Unrecognized net obligation (20,155) (25,934) 23,363 25,287
---------------------------------------------------------------------------
Prepaid (accrued) benefit
cost $ 80,148 $ 53,837 $ (77,986) $(74,030)
---------------------------------------------------------------------------
Weighted-Average Assumptions for the Measurement Period
Discount rate 6.70% 7.25-7.50% 6.70% 7.50%
Rate of compensation
increase 2.75-7.50 2.75-7.50 2.75-7.50 5.00
Expected return on plan
assets 10.00 9.50-10.00 -- --
---------------------------------------------------------------------------
Plan assets of the defined benefit retirement plan consisted primarily of marketable equity securities and bonds, including $43.3 million and $33.5 million of National City common stock at December 31, 1998 and 1997, respectively.
National City adopted a cash balance plan formula for the pension plan in the first quarter of 1998 resulting in a decrease of $95.8 million in the pension benefit obligation and a reduction of $14.9 million in pension costs during 1998. National City adopted an age-graded rate of compensation increase assumption in 1997 that did not have a material impact on the pension benefit obligation or pension costs.
Components of net defined benefit pension plan and post-retirement benefit plan costs follow:(1)
----------------------------------------------------------------
Pension Benefits
-------------------------------
(Dollars in Thousands) 1998 1997 1996
----------------------------------------------------------------
Service cost $ 34,192 $ 39,328 $ 35,338
Interest cost 64,753 66,594 61,431
Expected return on plan assets (110,585) (94,774) (83,060)
Amortization of prior service
cost (3,454) 1,789 2,546
Transition obligation (5,778) (5,952) (5,735)
Recognized net actuarial (loss) (6,531) (5,288) (1,780)
----------------------------------------------------------------
Net periodic (benefit) cost $ (27,403) $ 1,697 $ 8,740
----------------------------------------------------------------
----------------------------------------------------------------
Other Post-Retirement
Benefits
-------------------------------
(Dollars in Thousands) 1998 1997 1996
----------------------------------------------------------------
Service cost $ 2,072 $ 2,521 $ 2,247
Interest cost 7,363 7,752 7,322
Amortization of prior service
cost (648) (397) (586)
Transition obligation 1,923 1,923 1,923
Recognized net actuarial gain 125 54 96
----------------------------------------------------------------
Net periodic cost $ 10,835 $ 11,853 $ 11,002
----------------------------------------------------------------
(1) Using a measurement date of October 31, 1998 for the pension plans and
December 31, 1998 and 1997 for the postretirement plans. Various measurement
dates were used for pension plans in 1997 and 1996.
The health care trend rate assumption only affects those participants retired under the plan prior to April 1, 1989. The 1998 health care trend rate is projected to be 9.5 percent for participants under age 65 and 6.5 percent for participants over 65. These rates are assumed to decrease incrementally by .5 percentage point per year until they reach 5 percent and remain at that level thereafter. The health care trend rate assumption does not have a significant effect on the medical plan, therefore, a one percentage point change in the trend rate is not material in the determination of the accumulated postretirement benefit obligation or the ongoing expense.
The Corporation also maintains nonqualified supplemental retirement plans for certain key employees. All benefits provided under these plans are unfunded and any payments to plan participants are made by the Corporation. At December 31, 1998 and 1997, approximately $53.6 million and $41.5 million, respectively, were included in accrued expenses and other liabilities for these plans. For the years ended December 31, 1998, 1997 and 1996, expenses related to these plans was $24.9 million, $9.5 million and $20.2 million, respectively. The expense for 1998 and 1996 includes a $14.4 million and $11.4 million curtailment charge relating to supplemental executive retirement plans for former key employees of First of America and Integra Financial Corporation, respectively.
Substantially all employees with one or more years of service are eligible to contribute a portion of their pre-tax salary to a defined contribution plan. The Corporation may make contributions to the plan in varying amounts depending on the level of employee contributions. For the years ended 1998, 1997 and 1996, the expense related to this plan was $39.2 million, $40.4 million and $13.9 million, respectively. Contributions made in the form of National City shares by an ESOP reduced expense in 1996.
18. Income Taxes
The composition of income tax expense (benefit) follows:
-------------------------------------------------------------
For the Calendar Year
(Dollars in Thousands) 1998 1997 1996
-------------------------------------------------------------
Current:
Federal $340,074 $394,864 $442,193
State 6,429 9,194 25,113
-------------------------------------------------------------
Total current 346,503 404,058 467,306
Deferred:
Federal 222,194 107,267 (18,625)
State 7,899 6,514 (410)
-------------------------------------------------------------
Total deferred 230,093 113,781 (19,035)
-------------------------------------------------------------
Tax expense $576,596 $517,839 $448,271
-------------------------------------------------------------
Tax expense applicable
to securities
transactions $ 47,061 $ 28,484 $ 38,028
-------------------------------------------------------------
The effective tax rate differs from the statutory rate applicable to corporations as a result of permanent differences between accounting and taxable income as shown below:
-----------------------------------------------
For the Calendar Year
1998 1997 1996
-----------------------------------------------
Statutory rate 35.0% 35.0% 35.0%
Life insurance (2.0) (1.2) (1.6)
Tax-exempt income (1.6) (1.7) (1.8)
Merger charges and
goodwill 3.0 .9 1.2
Other .6 (1.4) (1.7)
-----------------------------------------------
Effective tax rate 35.0% 31.6% 31.1%
-----------------------------------------------
Significant components of deferred tax liabilities and assets as of December 31 are as follows:
------------------------------------------------------------- (Dollars in Thousands) 1998 1997 ------------------------------------------------------------- Deferred tax liabilities: Mortgage Servicing $125,644 $ 41,076 Lease accounting 357,713 214,901 Depreciation 8,711 28,304 Mark to market adjustments 139,467 181,761 Other - net 123,899 95,404 ------------------------------------------------------------- Total deferred tax liabilities 755,434 561,446 Deferred tax assets: Provision for losses 338,831 333,124 Employee benefits 24,737 39,801 Other - net 134,813 132,055 ------------------------------------------------------------- Total deferred tax assets 498,381 504,980 ------------------------------------------------------------- Net deferred tax liability $257,053 $ 56,466 -------------------------------------------------------------
19. Off-Balance Sheet Financial Agreements
The Corporation uses a variety of off-balance sheet financial instruments such as interest rate swaps, futures, options, forwards, and cap and floor contracts. These financial agreements, frequently called interest rate derivatives, enable the Corporation to efficiently manage its exposure to changes in interest rates. As with any financial instrument, derivatives have inherent risks. Market risk includes the risk of gains and losses that result from changes in interest rates. These gains and losses may be offset by other on- or off-balance sheet transactions. Credit risk is the risk that a counterparty to a derivative contract with an unrealized gain fails to perform according to the terms of the agreement. Credit risk can be measured as the cost of acquiring a new derivative agreement with cash flows identical to those of a defaulted agreement in the current interest rate environment. The credit exposure to counterparties is managed by limiting the aggregate amount of net unrealized gains in agreements outstanding, monitoring the size and the maturity structure of the derivative portfolio, applying uniform credit standards maintained for all activities with credit risk and by collateralizing unrealized gains. The Corporation has established bilateral collateral agreements with its major off-balance sheet counterparties that provide for exchanges of marketable securities to collateralize either party's unrealized gains. On December 31, 1998, these collateral agreements covered 90.3% of the notional amount of the derivative portfolio, and the Corporation was holding net U.S. government and agency securities with a market value of $148 million from various counterparties to collateralize unrealized gains. The Corporation has never experienced a credit loss associated with any interest rate derivative.
Interest Rate Risk Management: On December 31, 1998, the total notional amount of the interest rate swap portfolio used to manage interest rate sensitivity was $11.3 billion, which is an increase of $2.9 billion from December 31, 1997. The Corporation uses receive fixed interest rate swaps, receive fixed cancelable interest rate swaps and receive fixed indexed amortizing interest rate swaps to convert variable rate loans and securities into synthetic fixed rate instruments and to convert fixed rate funding sources into synthetic variable rate funding instruments. During 1998, the Corporation entered into $600 million of receive fixed and receive fixed cancelable interest rate swaps to hedge the issuance of fixed rate funding products and $975 million of receive fixed and receive fixed cancelable interest rate swaps to convert portions of its variable rate loan portfolios into synthetic fixed rate loans. During 1998, $1.5 billion of receive fixed interest rate swaps matured or amortized, $525 million of indexed amortizing receive fixed interest rate swaps matured or amortized and $575 million of receive fixed and receive fixed or cancelable interest rate swaps were terminated prior to maturity. These terminations generated pre-tax net gains of $6.4 million, recognized as an adjustment to the carrying value of the loan portfolio.
The Corporation uses pay fixed interest rate swaps to convert fixed rate loans and securities into synthetic variable rate instruments and to convert variable rate funding sources into synthetic fixed rate funding instruments. During 1998, the Corporation entered into $2.2 billion of pay fixed interest rate swaps, primarily to hedge fixed rate commercial loans and investment securities. During 1998, $251 million of pay fixed interest rate swaps were terminated prior to maturity. These terminations generated pre-tax net losses of $1.3 million, recognized as an adjustment to the carrying value of the securities portfolio.
The Corporation uses interest rate cap and floor contracts to help protect its interest margin in periods of extremely high or low interest rates. During 1998, the Corporation purchased $1.0 billion three-month Eurodollar caps with maturities of two years and an average strike rate of 6.5%.
The Corporation uses basis swaps to manage the short term repricing risk of variable rate assets and liabilities. During 1998, the Corporation entered into $1.5 billion of three-month to one-month libor basis swaps and $400 million of libor to commercial paper basis swaps to reduce the repricing risk in the funding of its variable rate loan portfolio.
On December 31, 1998, the Corporation had $14.3 million of net deferred gains on terminated derivative contracts and had no material derivative contracts outstanding that were hedging anticipated transactions.
Summary information with respect to the interest rate derivative portfolio used for interest rate risk management purposes follows:
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December 31, 1998
-------------------------------------------------------------------------
Weighted Average
--------------------------------- December 31,
1997
Notional Unrealized Unrealized Receive Pay Strike Life Notional
(Dollars in Thousands) Amount Gains Losses Rate Rate Rate (Years) Amount
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Interest Rate Swaps:
Receive fixed swaps $ 3,724,000 $116,660 $ (447) 6.39% 5.28% -- 3.0 $ 3,266,000
Pay fixed swaps 2,894,120 3,854 (59,123) 5.29 5.81 -- 5.3 895,754
Basis swaps 2,251,000 813 (464) 5.53 5.33 -- 3.0 325,000
Receive fixed callable swaps 1,867,000 37,724 (631) 6.62 5.44 -- 1.6 2,842,000
Receive fixed indexed amortizing swaps 509,319 1,074 -- 5.72 5.32 -- 1.1 1,034,493
Pay fixed callable swaps 82,968 -- (3,359) 5.55 6.35 -- 4.6 53,588
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Total interest rate swaps 11,328,407 160,125 (64,024) 8,416,835
Interest Rate Caps and Floors:
Three-month Eurodollar caps purchased 1,570,000 -- (1,902) -- -- 6.77% 1.3 500,000
Three-month Eurodollar
floors purchased 1,010,000 15,477 -- -- -- 5.78 2.7 1,400,000
One-month Eurodollar caps purchased 3,814 -- (101) -- -- 9.00 13.2 3,971
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Total interest rate caps and floors 2,583,814 15,477 (2,003) 1,903,971
Interest Rate Futures:
Futures sold 2,673,000 66 (118) -- -- -- -- 749,000
Futures purchased 379,000 28 (44) -- -- -- -- 212,000
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Total interest rate futures 3,052,000 94 (162) 961,000
Interest Rate Corridors Purchased:
1% Payout corridors -- -- -- -- -- -- -- 500,000
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Total interest rate swaps, caps,
floors, corridors & futures $16,964,221 $175,696 $(66,189) $11,781,806
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The variable rates in the interest rate swap contracts are primarily based on the three-month Eurodollar rate. The average variable rates included in the table on page 39 are those in effect in the specific contracts at December 31, 1998.
The following table details the expected notional maturities of off-balance sheet instruments used for interest-rate risk management at December 31, 1998:
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Greater
Less than 1 to 3 3 to 5 5 to 10 than 10
(Dollars in Thousands) 1 Year Years Years Years Years
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Receive fixed swaps $2,345,000 $2,545,319 $ 525,000 $ 260,000 $425,000
Pay fixed swaps 150,000 695,475 863,472 1,223,334 44,807
Basis swaps -- 1,725,000 526,000 -- --
Floors purchased 320,000 150,000 490,000 -- 50,000
Caps purchased -- 1,550,000 20,000 -- 3,814
Futures sold 796,000 1,042,000 525,000 310,000 --
Futures purchased 90,000 9,000 47,000 233,000 --
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Total $3,701,000 $7,716,794 $2,996,472 $2,026,334 $523,621
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Mortgage Servicing Risk Management: The Corporation uses off-balance sheet derivative contracts to hedge the market value of a portion of its mortgage servicing portfolio. The market value of the mortgage servicing portfolio is adversely affected when mortgage interest rates decline and mortgage loan prepayments increase. To hedge this exposure, the Corporation enters into receive fixed interest rate swaps, purchased and sold interest rate floors (net purchased options) and purchased interest rate caps. The Corporation also enters into interest rate swaps where the Corporation receives the periodic total return of principal only mortgage-backed securities and pays a variable rate based on one-month Eurodollar rates.
Information with respect to the interest rate derivative portfolio used for hedging mortgage servicing assets is summarized in the table below:
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December 31, 1998
------------------------------------------------------------------------
Weighted Average
---------------------------------
December 31,
Notional Unrealized Unrealized Receive Pay Strike Life 1997
-----------
(Dollars in Thousands) Amount Gains Losses Rate Rate Rate (Years) Notional Amount
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Interest Rate Swaps:
Receive fixed swaps $1,688,000 $ 32,716 $ (2,288) 5.79% 5.28% -- 6.0 $ 708,000
Principal only swaps 422,685 66,910 (8,714) -- 5.70 -- 2.4 141,715
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Total interest rate swaps 2,110,685 99,626 (11,002) 849,715
Interest Rate Caps and Floors:
Ten-year U.S. Treasury caps purchased 1,550,000 1,171 (1,652) -- -- 6.85% 3.8 225,000
Ten-year U.S. Treasury floors purchased 840,662 8,084 -- -- -- 4.13 1.4 1,015,662
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Total interest rate caps and floors 2,390,662 9,255 (1,652) 1,240,662
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Total interest rate swaps,
caps and floors $4,501,347 $108,881 $(12,654) $2,090,377
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Trading Activities: The Corporation also enters into off-balance sheet financial instruments for its trading account. These transactions are executed primarily with customers to facilitate their interest rate and foreign currency risk management strategies. The trading portfolio consists of derivative contracts with the Corporation's customers and offsetting derivative instruments, futures, forwards, option contracts and cash securities which effectively reduce the risk of market value fluctuations in the portfolio caused by changes in market conditions.
At December 31, 1998, the total notional amount of interest rate derivative contracts held for trading was $5.0 billion with a net market value of $18.6 million compared to $3.2 billion in notional and a net market value of $5.5 million at December 31, 1997. Trading revenue from derivatives totaled $15.1 million, $2.4 million and $3.4 million in 1998, 1997 and 1996, respectively.
All off-balance sheet contracts in the preceding tables are valued using cash flow projection models either acquired from third parties or developed in-house. Pricing models used for valuing derivative instruments are regularly validated by testing through comparison with other third parties. Valuations and notional maturities presented above are based on yield curves, forward yield curves, and implied volatilities that were observable in the cash and derivatives markets on December 31, 1998.
Other Off-Balance Sheet Commitments: The Corporation also enters into forward contracts related to its mortgage banking business. At December 31, 1998 and 1997, the Corporation had commitments to sell mortgages and mortgage-backed securities totaling $5.2 billion and $1.9 billion, respectively. These contracts mature in less than one year.
In the normal course of business, the Corporation makes various commitments to extend credit which are not reflected in the balance sheet. A summary of these commitments follows:
December 31
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(Dollars in Millions) 1998 1997
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Commitments to extend credit $36,073 $34,016
Standby letters of credit 3,227 2,938
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The credit risk associated with loan commitments and standby letters of credit is essentially the same as that involved in extending loans to customers and is subject to normal credit policies. Collateral is obtained based on management's credit assessment of the customer.
20. Other Contingent Liabilities
The Corporation or its subsidiaries are involved in a number of legal proceedings arising out of their businesses and regularly face various claims, including unasserted claims, which may ultimately result in litigation. While in management's opinion the financial statements would not be materially affected by the outcome of any present legal proceedings, commitments, or asserted claims, management is aware of a potential claim, currently unasserted, by the Internal Revenue Service concerning the Corporation's corporate-owned life insurance programs. While the exact nature of the potential claim is unknown, management believes that it has complied with all applicable tax laws and regulations with respect to such programs and will vigorously contest any claim.
21. Line of Business Reporting
National City operates three major lines of business. Corporate Banking includes lending and related financial services to large and medium-sized corporations. Retail Banking includes sales and distribution (direct lending, deposit-gathering, and small business services) and consumer finance. Fee-Based Businesses consists of mortgage banking, institutional trust, personal wealth management, and item processing (conducted through National Processing, Inc). The business units are identified by the products or services offered by the business unit and the channel through which the product or service is delivered. The accounting policies of the individual business units are the same as those of the Corporation described in Note 1.
The reported results reflect the underlying economics of the businesses. Expenses for centrally provided services are allocated based upon estimated usage of those services. The portion of the provision for loan losses that is not related to specific loans is allocated to the business unit based upon factors such as loan growth and net chargeoffs for the unit among other qualitative factors. The business units are match-funded and interest rate risk is centrally-managed by an investment/funding unit within the "Parent and other" line item. Transactions between business units are primarily conducted at fair value, resulting in profits that are eliminated for reporting consolidated results of operations.
Parent and other is comprised of several smaller business units including venture capital and the investment/funding unit as well as inter-segment income elimination and unallocated expenses. Selected segment information is included in the table on the following page.
Corporate Retail Fee-Based Parent Consolidated
(Dollars in Thousands) Banking Banking Businesses and Other Total
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1998
Net interest income (taxable equivalent) $666,765 $2,239,997 $ 122,215 $(77,104) $2,951,873
Provision for loan losses 16,378 227,628 2,074 (44,680) 201,400
-------- ---------- ---------- --------- ----------
Net interest income after provision 650,387 2,012,369 120,141 (32,424) 2,750,473
Noninterest income 171,610 653,690 1,227,922 260,920 2,314,142
Noninterest expense 320,172 1,533,656 1,020,484 502,801 3,377,113
-------- ---------- ---------- --------- ----------
Income (loss) before income taxes 501,825 1,132,403 327,579 (274,305) 1,687,502
Income tax expense (benefit) 177,814 408,773 116,813 (86,579) 616,821
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Net income (loss) $324,011 $ 723,630 $ 210,766 $(187,726) $1,070,681
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Inter-segment revenue (expense) $ -- $ 20,771 $ 51,302 $(72,073) $ --
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Average assets (In Millions) $ 19,676 $ 37,056 $ 1,958 $ 21,363 $ 80,053
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1997
Net interest income (taxable equivalent) $613,752 $2,173,125 $ 94,610 $(28,152) $2,853,335
Provision for loan losses 43,698 200,280 1,607 (20,218) 225,367
-------- ---------- ---------- --------- ----------
Net interest income after provision 570,054 1,972,845 93,003 (7,934) 2,627,968
Noninterest income 150,500 611,302 900,937 184,893 1,847,632
Noninterest expense 317,956 1,511,289 783,567 179,758 2,792,570
-------- ---------- ---------- --------- ----------
Income (loss) before income taxes 402,598 1,072,858 210,373 (2,799) 1,683,030
Income tax expense (benefit) 145,613 389,236 76,453 (50,466) 560,836
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Net income $256,985 $ 683,622 $ 133,920 $ 47,667 $1,122,194
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Inter-segment revenue (expense) $ -- $ 5,200 $ 18,972 $(24,172) $ --
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Average assets (In Millions) $ 15,561 $ 36,472 $ 1,507 $ 18,402 $ 71,942
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1996
Net interest income (taxable equivalent) $603,930 $2,253,319 $ 79,201 $(52,943) $2,883,507
Provision for loan losses 57,793 202,731 1,869 (22,457) 239,936
-------- ---------- ---------- --------- ----------
Net interest income after provision 546,137 2,050,588 77,332 (30,486) 2,643,571
Noninterest income 131,634 574,052 794,920 136,531 1,637,137
Noninterest expense 325,186 1,614,680 677,482 183,130 2,800,478
-------- ---------- ---------- --------- ----------
Income (loss) before income taxes 352,585 1,009,960 194,770 (77,085) 1,480,230
Income tax expense (benefit) 126,056 364,059 72,986 (76,387) 486,714
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Net income (loss) $226,529 $ 645,901 $ 121,784 $ (698) $ 993,516
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Inter-segment revenue (expense) $ -- $ 3,951 $ 7,657 $(11,608) $ --
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Average assets (In Millions) $ 14,283 $ 37,042 $ 1,284 $ 18,315 $ 70,924
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